Contemporary portfolio strategists find themselves continually pondering today’s investment climate, in which a peculiar set of circumstances reflects a world which is not supposed to exist. Like Alice in Wonderland, we are down The Rabbit Hole.
When I studied economics in the last century (a scary thought), professors described several highly unlikely phenomena:
- Negative interest rates – were unlikely to ever happen. Who would PAY a bank, or investor, to take your money and charge you for the privilege. Makes no sense to me, but the Swiss just issued ten year bonds at negative interest rates. It’s all the rage, in Europe.
- Money velocity is at 50 year lows, meaning money spent now is not further spent down the road. It is being hung up in savings, asset bubbles, and balance sheets. So much for “paying it forward”.
- Deflation persists in spite of massive printing of Dollars, Yen, and Euros. This is supposed to eventually raise prices, but inflation measures are benign and commodity prices keep falling. Where has all the money gone? See #4.
- The “Mythical” Liquidity Trap. The answer to where all the money has gone. It is piling up in savings accounts, banks, and business balance sheets, unspent and uninvested.
All of these are now today’s reality.
Central bank policy and weak global economies presumably have the world backed into a corner with money printing and low interest rates. Policy makers and economists are fond of asking how are we to get out of the Rabbit Hole and return to a normal world?
But what if that is not the right question?
The Real Long-term Issues
During recent client meetings, I have been described as being somewhat Doom and Gloom when describing market challenges. Let me assure you, I am not really all that negative. I like to think the glass is always more than half full, and opportunity abounds. We simply must have the patience to look for it. It would be an egregious error for a portfolio manager to look at the world the way we wish it to be, versus the way it is.
The real issues driving the lack of global economic progress are a triumvirate of trial and tribulation: 1) demographics, 2) globalization, and 3) accelerating technological advance. These are manifesting themselves in ways that are both amazing and scary.
The amazing: Amazon is pursuing delivery by drones, cars will soon be driverless, Intel has put a complete Wifi-enabled personal computer on a thumb drive, and smart phones have the capabilities of syupercomputers 20 years ago. Home TV’s are becoming fully interactive entertainment and communications systems. Who needs a stadium or a cinema? Electric cars are achieving market acceptance, and battery technology continues to advance. Believe it or not, a flying car will be offered for sale in 2107.
The scary: The middle class in the most advanced countries is being hollowed out, and wages are being compressed to global averages. Entire sets of human skills are about to be replaced by technology. When people retire, don’t work, or have a lower wage, Gross Domestic Product (GDP) expansion by standard measures is difficult, and that is an understatement. By some estimates, robots will be able to replace most human work output in 30 years. Finally, excluding immigration, populations are shrinking in the most developed nations.
What will people do?
The future may see smaller populations sustained by a combination of wages and public benefits, working fewer hours and receiving less pay, but with a standard of living that continues to improve beyond our wildest imagination.
Standards of living continue to improve with advances in healthcare and technology that are not measured in traditional GDP statistics. A “poor” US citizen lives a far better life than the same citizen just 50 years ago, or a rural Chinese peasant lives today. Most have access to a phone, housing, transportation, food, and healthcare.
It is difficult to imagine where this goes, but the late Isaac Asimov, one of the most prolific science fiction authors of the past 100 years, imagined such a world in his book “The Robots of Dawn.” It is eerily prescient of a possible future end game for many of these trends.
He writes of an Earth-sized world with an unchanging total population of 20,000. Each person lives on a grand, manicured estate served by armies of robot technicians. Healthcare has extended lifespans to 400 years barring accidents, and the residents are free to pursue whatever motivates them. They are scientists, artists, bureaucrats, or general layabouts, but they are free to do what they want with few limits and an inconceivable standard of living. Utopia?
So I think it is a fair question to ask; Do we need “climb out of the Rabbit Hole”, or learn to live within it (and profit from the change)? Is a retreat to the “old normal” the right path, or simply regression to an earlier reality that no longer fits an evolving model?
Will interest rates remain permanently low in a world where financial capital is oversupplied? If so, markets are which are overvalued by historical measures may not be in a new reality.
No one can predict where it all ends up, nor do we have answers to the challenges – it is an evolving, brave new world, but it is the one we invest in. Our responsibility is to look for the ever-present opportunities and manage risk, while diligently helping you stick to your plan. And the new reality still needs investors to build it.
The point of this trend discussion is to focus on the investable opportunities. We are increasing allocations to the technology, healthcare, and related sectors, as these represent the best opportunity for growth in a low growth (by GDP measures) economy. A recent new investment for aggressive accounts is Fanuc, a global manufacturer of industrial robots. Our income-oriented strategies also reflect our sector allocations with investments in cloud computing centers and healthcare facilities.
The US economy, and the dollar in particular, have moved in a big, positive way relative to the rest of the world. At some point this trend will turn, as markets regress back to mean valuations. We think it will happen soon, but need to see more evidence before adding to non-US assets.
Currently, an often asked question is about exposure to non-dollar assets. We examine net currency exposure at the individual security or fund level. Toyota may be a Japanese company, but it is really a global firm. It is a mix of currency exposures, one of the largest being dollars. The net of this is your portfolio favors dollars, but is not far from a dollar/non-dollar neutrality. We do not bet on currencies.
The future is through the looking glass – maybe economists should stop worrying about climbing out of the Rabbit hole – it may be part of a natural evolution into the brave new, scary, and amazing world we are investing in.